North West Oil Group, Inc. (NWOL)

[Vasco da Gama]

Is PetroChina Too Cheap, or Not Cheap Enough?

http://www.thestreet.com/_yahoo/markets/worldmarkets/10408673.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA

Are the beleaguered shares of PetroChina (PTR - Cramer's Take - Stockpickr) too cheap, or are they just cheaper than they were for a reason?

That's the question on many investors' minds in Hong Kong and China right now, after last week's surprise softer-than-expected earnings announcement, when the company said it made 145.6 billion yuan ($20.6 billion) in 2007, just 2.3% more than in the year before.

There was a time, not that long ago, when PetroChina could do no wrong. Last year, excitement abounded about the company's potential earnings going into 2008, and it traded at a 102% premium to rival global oil giants. Between January and November, its shares and ADRs rocketed in value. However, that premium has now shrunk to around 19%, according to Graham Cunningham, an analyst at Citigroup in Hong Kong.

Since the beginning of the year, shares in Hong Kong and the New York-traded ADRs are both down 30%, while the A-shares in China have become the punchline of jokes among mainland investors, off 28% since January. Going back to November, to an ill-fated debut of the dual-listed A-shares, they have plummeted 50%.

Some even blame the Shanghai IPO for the mainland market's overall woes -- the Shanghai Composite Index has lost 32% since Nov. 5. Still, PetroChina alone is likely not to blame, considering that performance is in line with the global selloff that many other equity markets have experienced.

The latest sign of trouble came last Wednesday, when PetroChina said its earnings growth for last year was lower than that of others in the sector, and lower than analysts' estimates, because of the rising costs of materials. For most oil companies, this has not posed too much of a problem, since the price of oil has risen in line, and in some cases more so, than the price they pay for materials to refine and produce it. The big problem has been that Beijing caps the price of oil for sale in China, limiting revenue and profit margins at the retail level.

PetroChina, a publicly listed portion of China's state-owned oil conglomerate, is the nation's second-largest refiner after China Petroleum & Chemical(SNP - Cramer's Take - Stockpickr). While China Petroleum has received 12.3 billion yuan ($1.7 billion) of subsidies to offset a decline in earnings, the government has yet to extend the same offer to PetroChina.

Now, investors in Hong Kong are debating whether the beaten-down shares offer value or if they may sell off further from here.

The debate has wider implications than just for the shares of the oil company itself -- PetroChina is the sixth-largest weighting in the Hang Seng, constituting 5.4% of the index, while it is the Shanghai Composite's largest weighting, accounting for a whopping 18% of the index. As such, two of Asia's largest markets are heavily affected by buying and selling in the company.

Most traders prefer PetroChina's cousin CNOOC(CEO - Cramer's Take - Stockpickr) for similar reasons that Patrick Shultz recently outlined on TheStreet.comTV's China Watch -- high production growth and immunity to price caps. As an explorer, CNOOC is not affected as much by the resale price of oil. (CNOOC has traded in a volatile band so far this year, falling by 23% in Hong Kong.)

"While PetroChina has corrected with the H-share bubble back into reasonable territory, it doesn't stand out as exceptional value relative to global competitors in the sector," writes Citigroup's Cunningham in a recent research note. By contrast, Cunningham says CNOOC offers "outstanding value", since it has a premium of just 9% to its global competitors, and compound growth in oil and gas production of 16% a year, or a total of 56% in the last three years.

"Because of the lackluster refinery business, PetroChina does not look good now, so I don't think people will get back into the stock in a big way," says Alex Wong, a director of Ample Financial Group in Hong Kong. Wong says that until China eases the price controls on oil, equity investors should look elsewhere.

Not all market participants agree with the bearish forecasts for PetroChina, however. Peter So, head of Hong Kong and China strategy for DBS Vickers in Hong Kong, says the argument comes down to a distinction -- upstream and downstream operations. Upstream oil operations are those that focus on the production of oil, such as CNOOC, whereas downstream oil companies mostly sell it, such as Sinopec Shanghai Petrochemical(SHI - Cramer's Take - Stockpickr). Whereas upstream operators benefit from high oil prices, downstream ones suffer.

PetroChina is caught in the middle, both producing and selling oil. As such, it can hedge its bets on price hikes in black gold, benefiting from them in its production business, according to So.

"At current levels PetroChina can benefit from earnings upgrades in mid-2008. The market is pricing earnings around an average of $85 a barrel for oil, so if it's any higher, everyone will have to upgrade their earnings forecasts over the summer," says So.

Still, even if PetroChina makes more money than expected in its upstream business, growth is slow, and it is losing heavily on downstream operations, says Castor Pang, a buy side analyst for Sun Hung Kai in Hong Kong. Pang is in the CNOOC camp.

"Overall profitability for 2008 is not optimistic for PetroChina. At the moment it is not the right time to buy, because everyone seems to be switching their focus from PetroChina to CNOOC," says Pang. He does though foresee another rise in oil prices.

Whether PetroChina can convince investors that it's worth the money in a white-hot commodity bull market may depend on its powers of persuasion in Shanghai.

In that respect, PetroChina is less in control of its immediate destiny, but the company can at least take solace in the fact that it's not alone. It's becoming common to see dual-listed shares rise on the Chinese mainland, then do so in Hong Kong, and finally in New York-listed ADRs.

Lately, Asian markets have been abounding with rumors that Beijing officials are turning their attention to bolstering the falling domestic markets. The most recent of such rumors is that they will slash the stamp duty on share purchases. In that case, then, the next rally or dip of shares in the largest company in the world, by total market cap, may rest on whether or not a Chinese market rumor comes true.